Inflation-focused policy

Even as the repo and reverse repo rates have been raised, the rising rate cycle is seen tapering off in future.

The Reserve Bank of India (RBI) came up with a relatively more hawkish view on Thursday, raising repo rates by 25 basis points (bps) to six per cent and reverse repo rate by 50 bps (25 bps more than expectation) to five per cent. The move spooked the equity and debt markets briefly, though they had already priced in a 25-basis-point repo rate hike.

However, the central bank also indicated the thrust on the economy normalisation process will become a less significant motivator for further policy actions, as current and expected macroeconomic conditions become more important.

Analysts expect the rate hikes to taper off going ahead, as inflation comes under control. While there is some evidence of a moderating trend, with the provisional Wholesale Price Index (WPI) down to 8.5 per cent in August (according to the new series), as compared to 9.7 per cent in July, the central bank pointed that the inflation rate was still unacceptably high.

Moses Harding, executive vice-president, Global markets, IndusInd Bank expects tight monetary control till the food and fuel price inflation dips below 10 per cent and WPI below seven per cent. However, economists believe the base effect, improving kharif output prospects and the monetary tightening should help lower inflationary pressures. Dun and Bradstreet expects WPI inflation to moderate to six per cent by December and further to three per cent by March 2011.

Analysts say the rise in the reverse repo rates will not have any immediate impact, as call rates are currently ruling above six per cent. The move was targeted to maintain the shorter-end of the yield curve at higher levels and to further allow efficient transmission of monetary policy rates to markets, even if the liquidity situation eases, to make the reverse repo rate the operating policy rate, as opposed to the current scenario where the repo rate is the key.

The reverse repo rate is the window through which banks park funds with RBI, while the repo rate is the one at which the central bank lends.

Despite RBI’s concerns on volatility of capital flows, the bias is towards steady inflows. Analysts expect the rupee to trade at 46.00-46.35 in the near-to-medium term. The expected impact on the rupee exchange rate from the surge in inflows dragged the BSE IT index by 2.3 per cent to 5813.27 over its previous close, with all the major scrips ending weak on Thursday.

The rate hike was priced in for the large part, say analysts, adding that in a scenario of strong economic growth, higher borrowing cost is not expected to have a significant impact.